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Adventures in the food chain: when Wal-Mart begins selling groceries in small-town America, what's a Kroger to do?

The new Wal-Mart store in Batesville was obviously supposed to be red, white and blue, but the white paint dried a shade gray. You don't have to be an English major to find symbolism in that.

Many Americans intensely dislike Wal-Mart, but for every person who feels that way, 20 or more believe that Wal-Mart hung the moon. If you don't know what Wal-Mart is, just be patient. Sooner or later it will come your way. Of course, if you're a proprietor of a store in small-town America, you hope it won't. Over the past 30 years Wal-Mart -- the discount-store chain started by the late Sam Walton of Bentonville -- has systematically moved into small local-hub communities and provided customers with the kind of shopping experience they formerly had only dreamed about.

Wal-Mart stores are big, modern, well-lighted places that carry everything from tires to toys to picture hangers to clothes, and all at what the company says are "everyday low prices." As a result, Wal-Mart has siphoned market share from virtually every merchant on Main Street, U.S.A. In the process, the chain has become the undisputed king of general-merchandise retailers, supplanting such giants as Sears and Kmart and making Sam Walton a billionaire many times over.

Batesville, an energetic little hill-country town of 9,200 and the seat of Independence County, had had a Wal-Mart store for years. But that store was closed and then essentially folded into the red, gray and blue monster that roared to life one spring day last year and began pulling the community in all directions. If this had been merely another traditional Wal-Mart opening, the event might have passed without notice; after all, 1,784 such stores are already in business and, on average, another opens every other day. But the Batesville store was anything but a traditional Wal-Mart. It was gigantic, offering -- in addition to general merchandise -- a snack counter, an auto-repair shop, a bank, a one-hour film processor, a hair salon, a photocopy center, a Miracle Ear outlet and a portrait gallery. And it sold groceries.

The Batesville store was a Supercenter -- only the sixth such store in the nation, after four in Missouri and one in Oklahoma. Until it opened, few people in Batesville had any inkling of the significance of Wal-Mart's opening a grocery store. But a handful of people did understand -- the proprietors of the rural convenience stores in the surrounding area and the managers of the supermarkets in Batesville proper.

The person who probably understood best was John Ed Smith, the manager of the local Kroger store. Kroger, the nation's No. 1 supermarket chain, had long dominated the grocery business in Batesville. "Dominated" may be too strong a word; in fact Kroger had co-existed peacefully with Harvest Foods (formerly Safeway), Town and Country, Price Chopper and the independent Dixie's Supermarket. Though Kroger owned the top market share, 21 percent, all the town's grocers enjoyed modest profits and the kind of cozy balance of power possible among business people who are also neighbors.

But John Ed Smith understood -- because the people at his company's headquarters, in Cincinnati, made sure he did -- that Wal-Mart's entering the supermarket business was a major event. It was, in the words of a veteran grocer, "one of those revolutions that come from time to time, disrupting the market and changing the code of conduct of doing business."

Soon everybody in Batesville -- and most people within a 50-mile radius -- understood, too. Because Kroger didn't wait to be bludgeoned by Wal-Mart's everyday low prices. Before the Supercenter even opened, Smith took the offensive, slashing the price of a gallon of milk from $2.59 to $1.69. Wal-Mart's response was a gleeful ad in the local newspaper, The Batesville Guard: "We're Already Lowering Your Prices!"

Soon after the Supercenter opened, Kroger dropped milk to 58 cents a gallon and bread to a nickel a loaf. This was only the beginning, however. What became known as the milk war lasted for 16 brutal weeks, during which Kroger and Wal-Mart aggressively sold below-cost milk, cut-rate bread, rock-bottom bananas and so on, and everybody else tried to compete without going broke. Most of the other supermarkets met the milk prices, but did so defensively and with much kicking and screaming. The local milk distributor -- who serviced the outlying convenience stores but not the majority of the supermarkets -- saw his business decline 60 percent during that four-month period. Some of his customers lost 50 percent of their volume; they simply stood around dusting their unsold stock and watching cars zoom past on the Batesville highway.

Meanwhile, in Batesville, Harrison Avenue, the street that runs in front of the Supercenter, was becoming clogged with cars and trucks and even tour buses full of shoppers from out of town. People who lived on streets intersecting Harrison suddenly had to wait for what seemed like hours to make a simple left turn. By August 1, more than 12 weeks after Kroger's first major price cut, milk was steady at 58 cents a gallon (after some early fluctuation), bread was at nine cents a loaf and a pound of bananas was going for 19 cents. A gallon of milk now regularly cost less than a pint of milk had just weeks earlier. Supermarkets hung out banners announcing triple coupon savings, and county farmers discovered that feeding their hogs milk was less expensive than buying the normal protein supplements.

Neighbor turned against neighbor -- Smith and Paul Gollhofer, then the manager of Wal-Mart, are Kiwanis brothers ("I know John Ed, but business is business," Gollhofer said) -- and eventually a pattern began to develop: Most Batesville residents continued to buy their groceries at Kroger and the other grocery stores of long standing, and the people from out in the county went to Wal-Mart. Put no matter who they were or where they bought, shoppers -- especially those with either milk-guzzling teen-agers or lots of hogs -- were blinded by their good fortune. Even Batesville's mayor got caught up in the spoils of war. "I love milk," Mayor Jim Barnett (pronounced Barn-et) says, "and I drank more milk than I ever have. I didn't think about it early, but the worst effect was on the small stores."

John Ed Smith publicly took credit for bringing about this windfall. "What you see is what we've done," he told Frank Wallis of the Guard. Before the summer was over, Kroger temporarily offered free milk, and Smith became the first POW of the conflict when he was arrested for refusing to sell 50 gallons of milk to a customer, thereby violating an arcane state law that prohibits limits on purchases of dairy products. The charges were eventually dropped, and a convenience-store owner admitted that he and the local milk distributor had plotted the volume purchase in an attempt to stop the milk war that was killing them.

Eventually the war did stop, at just about the time a former Federal Trade Commission lawyer began making noises about calling in the feds to investigate below-cost pricing. Last March, milk was at $1.79 -- right at cost -- and Batesville had settled back into a routine.

Instead of putting anyone out of business, the Supercenter has contributed to a 12 percent increase in county sales tax revenues. In other words, Wal-Mart has expanded the market, and although no one is willing to give a marketshare ranking anymore, Kroger is reportedly doing about the same dollar volume as before. Paul Gollhofer has retired, John Ed Smith has returned to business as usual and Wal-Mart headquarters has shifted its attention to other Supercenters opening soon in other towns across America. Now, months after the end of the milk war, you'd be hard-pressed to see that anything has happened here.

And yet something did happen. The question is, what?

To answer that, you have to know a little about the forces at work in John Ed Smith's life. Smith is a career grocery man, which means that every morning he gets up and unlocks the store and manages the merchandising of some 48,000 items, trying to anticipate (or react to) the moods of fickle consumers while fighting off competitors, not just in other supermarkets but also in convenience stores, wholesale clubs, mass-merchandise stores like Kmart and Wal-Mart, and now in the Supercenters. Smith has a good day when he nets one cent on the dollar.

Stability has never been a hallmark of the retail food industry, for two main reasons: First, profit margins are frighteningly narrow. Taken together, supermarkets (defined as stores that generate at least $2 million annually) and grocery stores produce $640.2 billion in yearly sales. In 1990-91, the industry's net profit was 0.96 percent -- less than a penny on the dollar. And second, the industry is caught between two notoriously unpredictable forces, the cost of food and the quirkiness of consumers. Rain in California or drought in Kansas can drive food prices through the roof, and higher prices can greatly affect consumer behavior. If the consumer walks, food spoils. No other industry has to provide such a constant and voluminous stream of vital, perishable and affordable goods. The retail food industry can't wait for Christmas to bail it out; food is elemental, and that makes selling groceries a life-or-death matter for both the customers and the stores.

From the days of the earliest general stores, which sold a little of whatever consumer goods were available, somebody has always been trying to divine what the consumer is going to want next. So the general store found itself competing with the specialized store -- the bakery, the butcher shop, the grocery store, the produce shop. Then, in the 1930s, hard times decreed lower prices, which required higher volume, which called for larger stores. A man named Michael Cullen came up with the idea for a "warehouse grocery," essentially putting all those specialized stores back under one roof. But Cullen added other factors into the equation low-rent location (such as an abandoned garage), night hours, self-service, and bold advertising. Mom-and-pop grocers felt, understandably, that these innovations placed them at an unfair disadvantage.

Indeed, small grocers were essentially doomed: In 1930 the shopping cart was invented. By 1940 there were 6,000 supermarkets in the U.S. Ten years later, 14,000 had opened, and by 1960 the number was 30,000. For most of that time the economy was strong, and supermarket growth continued with little resistance. Then came the '60s. Inflation hit hard, and supermarkets had to devise gimmicks like trading stamps in order to hold on to penny-pinching customers. But other changes took place in life in the '60s: Everything in American society seemed ready to be redefined.

It was in 1962 that Sam Walton started Wal-Mart.

During the next 20 years, supermarkets -- which had responded slowly to the changing times -- found themselves caught in yet another turn of the cycle. Consumers were making increasing use of fast-food restaurants and convenience stores. Meanwhile, mass merchandisers such as Wal-Mart and Kmart and Target were looking for ways to realize retailing's mythic dream of one-stop shopping. Wal-Mart really took off in the '70s, saturating the South (where in some states the current ratio is one Wal-Mart store for every 40,000 people). Since then, it has moved into the Midwest, the West and, just recently, the Northeast.

And as the company has expanded, its stores have steadily grown larger -- from around 35,000 SF in the '70s to between 60,000-90,000 in the '80s and 115,000 at the beginning of the '90s. "There were two parts of their thinking," Peter Monash, a retail consultant who has worked with Wal-Mart, says about the company's strategy in the early 1980s: "One, to allow customers more space to mill about, and two, to carry a limited number of food items, such as ketchup, coffee, snack foods." So began the process that has culminated in the Supercenters.

A rule of thumb in the retail business is that the gross margin on food is lower than the margin on general merchandise, which means that if you want to make money on food, you do it with volume. In 1983 Wal-Mart intensified its invasion of the retail food industry by launching Sam's Clubs. These are 105,000- to 130,000-SF warehouse stores where, for a membership fee of $25 a year, customers can stock up on everything from TVs and overcoats to oatmeal and diapers. Then, beginning in 1987, Wal-Mart went mega, opening a handful of the aptly named Hypermart USAs, 225,000-SF behemoths that were originally explored as the Wal-Marts of the future. Hypermarts -- which have since yielded to the more manageable Supercenters -- are nothing short of undivided malls with common checkout counters. The idea is, you back your truck up to the door and take home 400 pounds of steak and a freezer to put it in.

Among supermarketers, clubs and mass merchandisers are known as "alternative store formats" (also included are "deep-discount pharmacies," which now sell many items traditional to supermarkets). Alternative store formats are what the John Ed Smiths of the country spend sleepless nights contemplating. Last January, at the midwinter executive conference of the Food Marketing Institute, an association representing 1,500 food retailers and wholesalers, supermarket executives heard the bad news about how these aliens have invaded their turf: In 1986 the grocery-related volume of the alternative stores had reached $8.2 billion; by 1991 it had reached $25.6 billion. On an average day a club can deliver a 26-percent price advantage for a grocery basket of goods available at both clubs and supermarkets; a mass merchandiser can deliver a 15-percent advantage. Sixty percent of a club's sales are in grocery-related products. Alternative formats have already stolen supermarkets' dominance in paper goods and health and beauty products, and they are about to do the same in coffee, soft drinks, snacks, pet supplies and laundry and cleaning items.

If alternative retailers can inflict that much damage without even owning full grocery stores, imagine how much havoc the Supercenters are going to wreak.

On a Wednesday morning at the Batesville Supercenter, a few dozen senior citizens sit in the snack shop playing bingo and eating doughnuts, courtesy of Wal-Mart. One woman wins a blanket, another a basket of fruit. The games go on for an hour every Wednesday, beginning at 8 a.m. Players are usually lined up in the parking lot by 7:45.

But as you walk the aisles of this cavernous structure, you can't miss the reminders that Wal-Mart didn't come here just to play games. Banners proclaiming "WE'LL MATCH IT!" (any competitor's advertised price) hang from the roof supports. The shelves are a patchwork of red-marked price signs, showing Kroger's price and then Wal-Mart's: Popsicle Banana -- Kroger $2.25, Wal-Mart $1.75. DM Spinach -- Kroger 71 cents, Wal-Mart 59 cents. Kosher spears -- Kroger $2.09, Wal-Mart $1.78. Liquid Tide with Bleach -- Kroger $5.69, Wal-Mart $3.97. At the check-out counter, a basket of items on display reminds you how silly it is to shop a competitor and then come here to have the price matched; why not just shop at Wal-Mart and get everyday low prices?

Over at Kroger, Smith is doing what he can to compete. Instead of everyday low prices, he -- like most supermarketers -- uses a high-low pricing strategy, in which weekly specials play an important role in drawing customers to the store. Figuring out how to make money with a supermarket used to be easier than it is today. When Michael Cullen started the first supermarket, he devised a formula of so many items at cost, so many at plus 5 percent, so many at plus 15 percent and so many at plus 20 percent. "Today, there are no formulas," says Tim Hammonds, the vice president of research for the Food Marketing Institute. "Supermarkets carry general merchandise now, and the mark-up is higher on toasters than on groceries. That's why you can't devise a formula."

Also, electronic scanning, which came in during the '80s -- and which brought greater efficiency to supermarkets -- has added a certain manic quality to the business of stocking and pricing.

"The problem is," Robert Messenger writes in Prepared Foods magazine, "the time period for a product to succeed has been condensed because so many items are competing for the same slot. If a product, through scanning data, does not show significant early results, it can end up discontinued. Given more time to compete, it might succeed.

That passage contains an eerie echo of the fire that network television programmers came under in the early '80s. We all know what has happened to the networks.

Wal-Mart, however, seems firm and focused, and that gives the company amazing strength. In the David and Goliath story, Goliath is terrifying because of his brute size. In the grocery industry, Wal-Mart is terrifying because it has attained the size of Goliath by being as nimble as David.

"One reason Wal-Mart is so successful," the consultant Peter Monash says, "is that they've figured out how to lower the cost of doing business -- payroll insurance, what have you. Of the three major retailers, Sears' cost of doing business is in the low 30-percent range, which means that 30-something cents of every dollar goes to overhead. Kmart's percentage is in the low 20s. Wal-Mart's is 15.2 percent." Few industry observers doubt that Wal-Mart can transfer this leanness to food retailing -- a leanness that allows the company to pass on savings to the customer, which in turn attracts more business, which in turn lowers the cost of doing business.

The company's vaunted efficiency takes many forms, but the sum of its parts is self-sufficiency. For one thing, Wal-Mart reduces its dependence on branded products by creating its own private-label brands. Company buyers wield the huge stick of centralized purchasing, which, with such volume, rapidly whips manufacturers into line. More important, though, Wal-Mart has invested heavily in a space-age technology that improves distribution and ensures that each store can respond quickly to customers' needs. "Wal-Mart has the largest privately owned satellite system in the U.S.," John Cook of McKinsey & Co., a consulting firm, told the assembled (and presumably trembling) supermarketers at the FMI winter meeting. "Each store transmits scanning results and other data to Bentonville, the headquarters, where senior management can broadcast messages back to the store. Some manufacturers have hooked directly into this system and are working to drive factory production off retail sales." In other words, the computer tells the manufacturer which items are moving and which are not, so that production can be planned accordingly.

Wal-Mart is still learning the grocery business -- whose critical distinguishing feature is perishables -- but no one expects it to fail. "What?" says Arthur Markowitz, of Discount Store News. "You think they're suddenly going to get dumb when they've been so smart?" Last year Wal-Mart bought retail food expertise in the form of a 20-store grocery chain, and now most observers say the company need only work out the bugs. Also, the Supercenters are much closer than the urban Hypermarts to Sam Walton's original vision: "Going into small towns where people have no place else to go," as Peter Monash puts it, "and being king of the hill." Supercenters are intended to draw from a radius of 30 to 60 miles; a 1987 market study puts the number of people within 50 miles of Batesville at 184,000. "The economics of these stores are not yet clear," John Cook told the FMI audience, "but if they are successful, Wal-Mart, with its resources, could grow them rapidly and potentially change the way America shops for groceries."

In the retail food industry, stores typically meet new competition with a price war (though, as Dixie Carpenter, of Batesville, says, "After about four weeks, everybody usually settles back to normal"). But the Wal-Mart threat is seen as potentially cataclysmic. The Batesville Kroger is the first supermarket to come out swinging. In 1988, when Wal-Mart opened its first Supercenter, in Washington, Mo., the local independent IGA supermarket elected to close rather than face that kind of competition.

A story like that tends to provoke the question that has been asked about Wal-Mart in thousands of towns across America: Is it fair? Should a company be so large and powerful? Should anybody have such deep pockets that he can sell certain items below cost seemingly forever, possibly forcing others out of business in the process?

"I've heard lots of people say that Wal-Mart is disruptive and destructive to a community," says an attorney on the staff of the FTC's Bureau of Competition, "that they go in and use predatory pricing to put others out of business and that once they've established dominance, they then reap the rewards of monopoly. However, no one has ever come forward with proof of that pattern of behavior. If someone did, of course, it would be grounds for concern. But unless they are clearly anti-competitive -- i.e., predatory -- the feeling is they shouldn't be challenged, because the consumer will benefit in the long run."

The people asking the fairness question are usually either outsiders, such as journalists, or store owners facing imminent extinction. But retail food people seem to accept the rules of their rough-and-tumble game: Live by the markdown, die by the markdown. "Anything is fair in love and war and business," says Jake Foster, a former employee of Armour and then of Wetterau, and a former owner of an IGA store, Foster retired, went home to Pocahontas and bought two grocery stores, which he has since turned over to his children. "I wish Japan didn't sell cars in the U.S.," he says, "but I don't know how to stop them. Where are you going to draw the line in a free market?"

"The morality of the whole thing depends on where your sympathies lie," Peter Monash says. "If you're for the consumer, don't you want him to have the lowest prices? If so, and if Wal-Mart is out to be the best purchasing agent for the customer, then they're doing a great job. But if you're for the small merchant, who has a wife and a kid and a dog and is being put out of business, it's tough."

In fact, the retail food industry is about as good a place as any to observe natural selection in action. You know that picture showing a huge fish about to eat a smaller fish which in turn is about to eat an even tinier fish? Put white supermarket aprons on those fish and you've got the retail food industry. What we saw in Batesville, then, in spite of the local Kroger's apparently successful struggle to remain profitable, was the supermarket industry in a death frenzy, its corporate life flashing before its eyes.

Other such spectacles will occur as Wal-Mart rolls out its Supercenters. By the end of 1992, more than 20 of the giant stores will be open, in such towns as Tupelo, Miss.; Yukon, Okla.; and Pittsburg, Kan. Though Wal-Mart won't confirm it, speculation is that 300 Supercenters will be operating by 1997.

And so now may be the time for other chains to fly in the face of the mega trend. "Niche marketing is the name of the game," Tim Hammonds says. "Wal-Mart can't be all things to all people," adds Woody Whyte, an analyst who follows Wal-Mart for Stephens Inc. "Kroger, and others, may have to rethink their market strategy. They may have to relinquish some of the Batesvilles and go smaller but more high end. They need to get out of the path of the steamroller."

Jake Foster, who knew Sam Walton (who died April 5 after a long illness), can imagine another future. "For all that's said about Walton, I believe he was in the business for the pleasure of doing business, not to put others out. But as the company grows and goes on without him, the positive influence of his personal style is bound to diminish." In fact, Wal-Mart is already beginning to show signs of arrogance: This is a company built on downhome values, and yet phone calls don't ever seem to get returned. In the field brisk, blow-dried, home-office types swagger self-importantly through the Batesville aisles, a far cry from the image of Sam Walton in his $70 suit.

In this survival-of-the fittest business, hubris has relegated more than one player to the endangered-species list. "Why did A&P used to be number one?" Foster says. "Why Safeway?" He has an answer: "It's because they rested on their laurels."

Out there on the horizon, Foster says, are Home Depot and Office Warehouse, the so-called "category killers." If Wal-Mart Supercenters are today's general store incarnate, these huge single-category warehouse stores are the boutiques of the future. They represent the same old cycle, only bigger.

"Home Depot handles a significant percentage of what Wal-Mart handles," Foster says. "Wal-Mart's eventually going to have to change its mix. And that's why the consumer doesn't bother looking too far down the road. We're a now society. We have confidence in the market. We know that if Wal-Mart puts somebody out of business, somebody else will come along and put Wal-Mart out."
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Title Annotation:Wal-Mart Stores Inc.; Kroger Co.
Author:Morgan, James
Publication:Arkansas Business
Date:Aug 17, 1992
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